White House, Fed Must Tout Tax Cuts

The economy is at a standstill and perhaps even headed for yet another contraction, with 43,000 jobs lost last month and stocks in the worst bear market in 30 years. Business investment fell an average of 4.1 percent in the first two quarters of this year, and current data indicate there is no investment recovery in sight during the second half of the year. Meanwhile, Congress, the administration and the Federal Reserve Board stand around in paralysis, each waiting for the other to act, all fearful of taking action themselves.

Monetary policy remains too tight, but simply cutting interest rates further is not the answer. War-and recession-induced budget deficits are on the rise, but tight fiscal policy in the form of continuing high tax rates only drags the economy down more. Corporations increasingly flee to foreign countries where tax rates are more reasonable, but attempting to build a statutory “Berlin Wall” in the tax code to prevent them from leaving is unjust and counterproductive. Corporate scandals must be cleaned up, but crushing businesses – especially high technology and telecommunications – with unreasonable regulations only undermines productivity growth.

Political insiders and participants in financial markets are fretting over what happens after Fed Chairman Alan Greenspan departs the scene. As Harvard economist Gregory Mankiw put it last year, “Imagine that Greenspan’s successor decides to continue the monetary policy of the Greenspan era, how would he do it? The policy has never been fully explained.

Greenspan has been a good friend over the years, but he and I have disagreed vehemently over monetary policy ever since he said it was “irrational” to buy stock in America. I also have taken exception to the Fed’s practice of attempting to steer monetary policy by simply targeting interest rates lower or higher based on the chairman’s personal discretion. I have urged him repeatedly to lead the Fed toward adoption of a rule-based monetary policy where the rate of money creation is determined by objective financial-market indicators, including the price of gold, the value of the dollar and other commodity prices.

Last August, four months before the National Bureau of Economic Research officially proclaimed that the economy fell into recession in March 2001, I wrote Greenspan warning that the economy was contracting and that the blame rested squarely on the Fed’s doorstep. I also urged him to realize that his hope for a lasting legacy lies in what he does now to move the world toward a new global framework for monetary policy in which the dollar is as good as gold, not only here at home but also around the world.

Greenspan has not led the Fed to change its ways, and because he hasn’t, the Fed is in danger of repeating the Bank of Japan’s folly of gradually lowering interest rates all the way to zero without successfully reviving the economy. Interest rates are at 40-year lows today, yet firms without access to the bond market, which is to say most of them, are finding it more and more difficult to obtain credit to start up new operations or expand existing ones.

It is dangerous for the president to remain mum on monetary policy and to stand idly aside, allowing one or two congressional mavens petrified of deficits to scuttle his tax rate reduction proposals. If Congress cannot find the courage to overhaul and simplify the tax code, at least it could enact the proposals favored by the president to raise the contribution limits on tax-deferred retirement accounts, increase deductions for capital losses, cut the tax rate on capital gains and give relief from double taxation of dividends.

It’s time for the president to get together with Greenspan and explain that he intends to persuade Congress to cut tax rates. Tax rate reductions will increase the demand for liquidity, which the Fed would fail to accommodate if it persisted in its current interest-rate targeting. Therefore, now is the time for the Fed to facilitate tax rate reductions by adopting a stable price rule based on commodities whose prices are sensitive to deflation and inflation.

In addition, the president has wide latitude to act immediately to ease the regulatory burden on high technology, telecommunications and other sectors of the economy.

He should also reverse the tariff increases of earlier this year, which are nothing but a tax increase on consumers.

Finally, Congress also could take a politically safe – but important – step toward fundamental tax reform by creating Enterprise Zones of Choice in economically lagging areas and in the territories where companies and individuals could be permitted to choose whether to be taxed under the current tax code or under a reformed code that does not punish work, saving, investment and entrepreneurial risk-taking.